Chapter 3.docx

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School

University of Ottawa

Department

Economics

Course

ECO1102

Professor

David Gray

Semester

Fall

Description

Chapter 3: Interdependence and the gains of trade
Gains from trade
Punch line: It is usually advantageous for countries, firms, individuals, or other economic units to
SPECIALIZE in the production of one or a few G & S, and TRADE the majority of their product away
in exchange for those G & S that they do NOT produce
– Basic principle # 5
-International trade is usually economically beneficial
- Parting words of Alan Greenspan, former chairman of the Fed
- “the world today faces a profound choice: to embrace the worldwide benefits of open
markets and open societies that pull people out of poverty or to embrace nativism, tribalism,
populism…Because of advancing technology, rising productivity, and the growth of trade and the
spread of free markets, the world of a global, capitalist economy…is vastly more flexible, resilient,
open, and self-correcting and fast-changing than it was…”
– Anti-thesis: the Robinson Crusoe economy of total self-sufficiency, which is called AUTARKY
– By specialization and trade, the total amount of production available for consumption is far higher
than it is in AUTARKY
-Who should specialize in what?
– Each economic unit should specialize in the production of the good in which they have a
COMPARATIVE ADVANTAGE
– trade for the good in which they do not have it
Comparative Advantage
As in the textbook, there are two producers, the farmer and the rancher, and two goods, meat and
potatoes
– Rancher has a comparative advantage in the production of meat if the gap between how well she
produces meat compared to how well she produces potatoes is greater than this same gap is for
farmer
– Equivalently, the rancher has a comparative advantage in the production of meat if he produces
meat with a lower opportunity cost in terms of potatoes than is the case for the farmer
• We will go with the other approach first
-Comparative advantage is determined by:
– First examining opportunity costs between production of the 2 goods WITHIN each person
separately
– Second, comparing the opportunity cost ratio BETWEEN the two parties
•Examining the ratio just means taking that number for the opportunity cost and
making a common denominator of one (across the two producers)
- Absolute advantage is determined by the pattern of absolute productivity
– Whichever country or person or unit is more productive in the production of a good has
the absolute advantage
– productivity = output / input It is not relevant for trade and specialization It is relevant for
determining living standards
-It is not relevant for trade and specialization -It is relevant for determining living standards
- Numerical example of comparative advantage from textbook
– Over the course of the day, the farmer can produce either [8 kg of meat and 0 kg of potatoes] OR
[0 kg of meat and 32 kg of potatoes]
• The farmer is thus 4 times as efficient in the production of potatoes as the farmer is in the
production of meat
• Another way of saying the same thing: opportunity cost is four-for-one
– - 4 kg of potatoes = + 1 kg of meat
– - ¼ kg of meat = +1 kg of potatoes
– The rancher can produce either [24 kg of meat and 0 kg of potatoes] OR [0 kg of meat and 48 kg of
potatoes]
• Although the rancher produces potatoes better than the rancher produces meat, she is only twice
as efficient in the production of potatoes as she is in meat
• Another way of saying the same thing: the opportunity cost is two-for-one
–+ 1 kg of meat = - 2 kg potatoes
–+ 1 kg of potatoes = - 1/2 kg of meat
– It follows that fa